AQR for NBFCs is a sheer bloodbath: India Ratings

The recent debacles — IL&FS and DHFL — have raised questions about the actual state of the books of mid-sized and larger NBFCs. A lot of these NBFCs have grown to the size of a mid-sized bank and the quantum of debt that they are refinancing is of much higher level.

The ever-increasing struggles of the non-banking financial companies (NBFCs) can be attributed to the quaint phenomenon of borrowing short and lending long. As risk averse banks are cutting back on lending to the sector, some NBFCs are finding it increasingly hard to access funding and and keep the growth cycle moving.

Not-so-impressive quality of assets of the NBFCs may compel the RBI to launch an asset quality review (AQR) for the NBFCs, something it initiated in 2015 under the former governor of the Reserve Bank of India Raghuram Rajan, with an aim to clean up the balance sheets of the banks. Indeed, the recognition of non-performing assets of banks improved and from a 4.3 per cent gross NPA ratio in March-end 2015 it shot up to 9.3 per cent in March-end 2019, bringing in transparency to the NPA recognition mechanism.

But will an AQR help the sector improve its asset quality or the mistakes from the past will come back haunting?

Pankaj Naik, associate director at India Ratings & Research said, “AQR for the NBFCs will be a sheer bloodbath. I don’t know what will be the outcome of the AQR. If you are doing an AQR for the banking system, you are pin pointing to 4-5 large financials… Refinancing of these large books is a challenge in itself. And doing an AQR for NBFC is a bigger challenge, as larger part of the market consists of retail asset financials, and AQR will not solve any problem there. And for wholesale books, AQR will kill their business model.”

The recent debacles — IL&FS scandal and DHFL default — have raised questions about the actual state of the books of mid-sized and larger NBFCs. A lot of these NBFCs have growth to the size of a mid-size bank and the quantum of debt that they are refinancing is of higher level.

Some experts feel that the AQR process for NBFCs will of course be painful and might or might not help sort out the uncertainty of the quality of assets.

Naik added, “RBI’s LCR mechanism for NBFCs can be helpful, as this will push some NBFCs to maintain on balance sheet liquidity to take care of their immediate liability payment.”

Since there is no lender of last resort to NBFCs, Naik believes the sector needs one. “NBFCs need to develop their own mechanism in terms of bringing more granularity to their loan book which can help them securitise assets and generate funds in the long run.”

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